OSC looked at 20 fundcos in last phase of probe

(March 17, 2005) The Ontario Securities Commission’s investigation into market timing practices in the mutual fund industry originally identified 20 fund companies as having suspicious activity, but determined the damage to investors was negligible in 15 of those funds, outgoing OSC chair David Brown revealed today.

“Of the 20 that were part of phase three [of the investigation], some of the 15 had identified market timing very early on themselves, and put a stop to it,” Brown told reporters following a speech in Toronto. “We were quite confident that any harm to investors that happened as they were dealing with the problem was negligible.”

These protective measures included instituting policies to refer suspicious trading activity to a review committee and using fair valuation techniques to reduce price discrepancies between stale values and current market value of securities within a fund’s portfolio.

“Balancing the fact that the harm to investors in these funds was negligible and that we thought these funds acted appropriately, we saw no reason for us to pursue them,” Brown said.

The OSC released its final report on the market timing investigation today, which resulted in enforcement actions against the remaining five fund companies. But the report does not name the 15 companies which were not subject to enforcement action.

“There was some evidence that they had been attacked, if you like, by the market timers, but they put a stop to it,” he said. “Our mandate is to be protective and preventative, not to be punitive. Those that had processes in place to detect this and had taken immediate steps to shut it down, didn’t need our assistance for protection and prevention.”

That “assistance” resulted in settlements with AGF, AIC, CI, Franklin Templeton and IG, which will return more than $205 million to investors.

Brown said there was no evidence of a conspiracy within the five sanctioned fundcos to allow market timing, but said there were “arrangements in place between some of the accounts and the fund.”

“Without the proper processes in place, it might go on for a period of time undetected,” Brown said. “I don’t think it could go for very long, given the massive scale with which the market timers were approaching this.”

In the eyes of the commission, the five fund companies who were the target of enforcement failed in their duty to protect the non-market timing investors.

The OSC maintains its position against naming account-holders who engaged in market timing activity, though, saying these investors did not owe any duty of care to their fellow investors within the funds in question.

“We believe it is a fund manager’s responsibility to put in place policies, procedures and other mechanisms to monitor trading that could be disruptive or harmful to the funds and take reasonable steps to protect the fund. The market timers owe no such duty to the other investors in the funds. They broke no laws,” Brown noted in his speech.

Brown declined to comment on the nature of these account-holders — whether they were hedge funds or pension funds, for example — but he did confirm that some of the account holders were non-Canadian entities.

The final report on the investigation reiterated that there was no sign of late trading or of insider activity, problems which were the focus of New York Attorney General Eliot Spitzer’s investigation south of the border.

“I can say with certainty that measures are in place to address market timing,” Brown said. “That of course was last year’s problem; we have to think about what next year’s problems might be and the years going beyond that.”

Brown praised the investigation for its quick response and for bringing together the provincial regulators as well as “the two affected self-regulatory organizations,” referring to participation by the IDA and the MFDA.

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“I think this is the approach that will increasingly be necessary, as new products and practices are introduced quickly in the fast-paced markets.”

IFIC welcomed the OSC report and the regulator’s move to declare the investigation officially closed.

“The interests of investors must always come first, as the guidelines we recommended to our members last summer indicate,” said Tom Hockin, IFIC president and CEO. “We now welcome the opportunity to help bring any additional refinements to IFIC’s present recommended approach to detecting and deterring inappropriate short-term trading.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(03/17/05)

Steven Lamb